Sunday, July 22, 2018

The Fundamental Contradiction In Trump's Economic Policy

Trump cut corporate and individual taxes to stimulate the economy.  This is a common use of fiscal policy to stimulate economic growth during a recession.  Lower corporate taxes encourages businesses to increase capital spending which stimulates the economy.  Cutting personal taxes also encourages consumer spending.  Capital spending and consumer spending are two of the major components of GDP.  Trump also understand that trade deficits shrink GDP.  He has been using tariffs to reduce imports in order to shrink US trade deficits.  What Trump does not understand is that there is a fundamental contradiction in his economic policies.

One of the contradictions is that tax cuts reduce government revenue.  The government has been forced to pay for rising budget deficits by borrowing more money.  That increases the demand for dollars which raises the value of dollars relative to foreign currencies.  That makes US products less competitive in foreign markets which must be paid for in more expensive dollars.  Consequently, US exports have not grown fast enough to shrink the US Trade deficit. 

The other problem with Trump's policies is that the Federal Reserve uses monetary policies to set interest rates.  The Fed raises interest rates when it wants to slow the economy down in order to deal with the threat of price inflation.  It has been raising interest rates in slow steps and it plans to continue using monetary policy to push interest rates upward.  That has a depressing effect on economic growth because businesses and consumers will borrow less money as the cost of borrowing increases. 

Trump sold his tax cuts and his use of tariffs as a plan to stimulate economic growth.  That plan has not worked as well as he hoped because it has put pressure on budget deficits and it has made US exports more expensive.  He has been using his Twitter account to criticize the monetary policies that are controlled by the Federal Reserve.  This is consistent with his usual practices.  He never takes responsibility for decisions that don't work.  He is setting the stage to blame the Fed for the failure of his tax and tariff policies to stimulate economic growth.  Ordinarily, US presidents might dislike the monetary policies that are being implemented by the Fed.  However, the usually do not publically criticize the Fed which was set up to be independent from the government.  Trump is not a typical president.  His attacks on the Fed are just the beginning.  He will maintain that his policies were the greatest use of fiscal policy in US history.  The Fed will have to take responsibility for their failure.

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